Market Lessons for Gatekeepers

Abstract

Market Lessons For Gatekeepers grows out of my earlier work on how intermediaries may work to alleviate problems of fraud in markets, as discussed in my articles on company registration (64 U. Chi. L. Rev. 567 (1997)) and securities fraud class actions (144 U. Penn. L. Rev. 903 (1996)). Where certifiers act as intermediaries between producers and purchasers in a market, contract alone, in many situations, should provide certifiers adequate incentives to signal product quality to purchasers and invest in their ability to screen accurately for different product qualities. Markets, however, may fail. In response, commentators have argued for legal liability on market intermediaries to force them into a certification role.

My paper takes an intermediate course. It first argues that lawmakers may have more success bolstering market incentives for intermediaries to act as certifiers where market defects exist rather than directly mandating third party gatekeeping.

The paper provides a simple economic model of the interaction of purchasers, producers, and third party certifiers -- taking into account the decision of certifiers to invest in screening accuracy as well as the decision of producers to invest in product quality -- to identify potential market defects. Where purchasers are uninformed on the quality levels of different certifiers in the market, lawmakers should provide information disclosure on certifiers' past history to allow the market to punish -- through lower prices -- certifiers that do not perform their screening function well. Similarly, where certifiers may cheat on their certification duties, I propose self-tailored liability, under which certifiers themselves would submit their desired level of screening procedures and accuracy to the government. The paper argues that certifiers should be allowed to bind (or not bind) themselves to these procedures for any fixed period of time and be able to choose to allow the government to publicize the procedures as well as impose civil or even criminal penalties for breach (and use public enforcement to obtain such penalties). Where all relevant market participants are linked through contract, self tailored liability provides certifiers a means of bonding themselves to a particular level of screening accuracy credibly.